THE BARRIERS OF SMALL FIRM DEVELOPMENT Dr Dariusz Nowak Poznan University of Economics Poland

INTRODUCTION

The experience of developed countries indicates how important, for the economy of the country and the pace of its growth, is small entrepreneurship, which constitutes the driving force of the economy. The sector of small-sized enterprises is regarded as the one which is able to adapt itself most rapidly to changing market situations, to notice new needs of customers and to fulfill them, to occupy these market areas that are unattractive for large and medium entities (Scarborough &Zimmerer, 2003 Sosnowska, 2005). They enter into a different kind of partnership, whichh leads to the creation and development of peculiar bonds (Schenk, 2001). However, from one side, they guarantee long-standing co-operation but on the other hand they contribute to the undertaking of new challenges, fixing new purposes and tasks, hence to innovative action (O’Regan & Ghobadian, 2005; O’Dwyer, 2009). This action is treated as the driving force of small-sized enterprise development. At the same time, they contribute to better and more effective use of possessed resources. A report of the European Commission has asserted that “Small and medium enterprises (SMEs) constitute the backbone of the European Economy” (Schmiemann, 2008). Many advanced economies feature programmes of public subsidies that target the research and development (R&D) activity of small firms, based on the thesis that they are essential for innovation but may face financing constraints owing to credit-market imperfections. It should be emphasised that examinations conducted in different countries indicate increase in innovation of these subjects, which involves co-operation with different individuals. In addition, they are elastic and adjust adaptively to market changes.

It should also be underlined that thanks to the high elasticity and the action resilience, it is easier for them to invest, to revise their scope of activity and also to solve any problems that occur innovatively (Pagano & Schivardi, 2003). These enterprises also constitute the main

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source absorbing unemployment because the greater part of the workforce is employed in this sector.

This paper aims at examining the basic barriers of small-sized enterprise development and the role individual limitations play in the competitiveness of small companies in Poland. The following hypothesis was posed: the development of small-sized enterprises is limited by the range of barriers of legal, administrative, fiscal and market character. This undermines their competitive position and prevents effective contest in the integrated European market.

In order to verify the posed hypotheses, the survey investigations were carried out in 2007 and 2008, among 133 enterprises active in the market of industrial goods in Poland. Investigations had a directional character, i.e. they were directed only at enterprises which had earlier expressed readiness for participation in them.

1. The essence of a small enterprise

Attempts to present the definition of small and medium enterprises (SME ) in the microeconomic, legal and sociological categories on the international, sub-national and national level were repeatedly entertained in scientific investigations concerning the SME sector. The demand was for the use of jurisprudence, applied law, statistical tax and an administrative register, as well as for banks and politics (Dominiak, 2005). These attempts were characterised by different expression, scope and form and were based on diverse criteria of classification. The number of employed workers is one of the criteria used (Deakins & Freel, 2003; Loecher, 2000). It is applied by the Organiszation for Economic Co-operation and Development, according to which enterprises employing fewer than 500 workers belong to the SME class (see Halley & Guilhon, 1997). For reporting purposes they were divided into the following groups: - Very small enterprises employing up to 19 workers - Small enterprises employing from 20 to 99 workers - Medium enterprises employing from 100 to 499 workers.

The presented division is in accordance with the classification used in the USA. However, it should be emphasised that the Small Business Administration, established by the US 2

congress, also applies quality criteria. It assumes that it must be a company with property independent from a different company or organisation and it must act on the local market and cannot dominate in its business. New recommendation of the European Commission of 6 May 2003 were implemented on 1 January 2005 by the European Union (EU). These define the SME sector differently. A micro-enterprise definition was introduced, i.e. an organization employing fewer than 10 people, on the assumption that its annual turnover does not exceed €2 million. The idea to expand the circle of SMEs was a way to introduce a new kind of beneficiary of public aid. In the opinion of the European Commission, micro-enterprises are particularly important for the development of entrepreneurship and the creation of new positions on the employment market.

Table 1. Classification of enterprises in the EU Type of enterprise

Micro-enterprise Small-sized enterprise Medium-sized enterprise

Classification Criterion Independence Criterion Balance Value in %

Financial Criterion Annual Turnover Value Up to 2 million € 2 - 10 million € 10 -50 million €

Up to €2 million €2 - 10 million €10 - 43 million

< 25 < 25 < 25

Employment Criterion AWU Below 10 persons 10-49 50-249

Source: http://ec.europa.eu/enterprises/index_en.htm 29.10.2009 The essential condition excluding an enterprise from the SME sector is the regulation of capital connections with different economic subjects. That means that the enterprise cannot be acknowledged as an SME if a different enterprise owns more than the 25% of its capital structure. Table 2. Quality criteria of SMEs Criterion Management system

Organisation

Share in the market

Production

Characteristic feature - managerial functions: the owner, personal managing - system of information: limited - management model: centralised - role of intuition: big - risk and control: owner's - directing and managing: direct - functional structure - organisational structure: simple - informational and decision-making connections: direct contact - task formalisation: little - delegation of entitlements: limited - elasticity of the structure: big - sense of direction: individual needs of customers - position: slight influence on demand and supply - market: local or regional - kind: laborious

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Finances Staff

Research and development

- work segmentation: little - kind of devices: universal - possibilities of cost reduction: limited - tendency to invest: big - structure of products: a few or several - market of stores: local or regional - capital ownership: one owner or a few persons - access to the capital market: little - classifications:  unqualified workers: small stake  graduates of higher education institutions: small stake - contact between workers: universal - research works: sense of direction towards customer needs - elements of innovation

Source: J. Bieliński, Zarządzanie wartością przedsiębiorstwa a alokacja kapitału, CeDeWu, Warsaw 2004, p. 240. J. Targalski, , Przedsiębiorczość i zarządzanie, C. H. Beck, Warszawa 2003:14.

2. SME in the country’s economy The importance of SMEs is widely discussed in domestic and foreign literature (Bergel & Vedie, 2003; Deakins & Freel, 2003; Spence, Schmidpeter & Habisch, 2003; Walczak-Duraj & Duraj, 2006). They are fundamental to the functioning of all market economies. They actively seek areas of the market which are not very attractive to big enterprises dealing with production on a mass scale (Deani, Brown & Bamford, 1998). Their main purpose is to fulfill local or regional demand or to manufacture specialist products and services for which the demand is slight and mostly short-lived (Sudoł, 1999). The production of co-operative elements or providing production services for large enterprises, which can focus on their basic tasks and invest more funds in the field of R&D, is also an essential domain of their activity. Thanks to that they achieve higher profitability and effectiveness than would be possible in the a situation where all tasks connected with the production of the given goods were carried out independentlhy Brouthers et al., 2009) Thus, the available production resources may be used more effectively, since they can adapt flexibly to the changes taking place in their environment (Gabryszak, 2006). The functioning of small-sized enterprises is a sign of the entrepreneurship and creativity of a society. There is a lack of such features among large companies, which have limited adaptability to variable environmental conditions. In countries with developed market structures they constitute the essential source of innovation (Herna´ndez-Espallardo & Delgado-Ballester, 2009). In this way they contribute to an increase in the competitive position of the entire economy. The basic features of small-sized enterprises are the following: 4

- Flexibility in accommodation to dynamically changing principles of the market - Ability to create new jobs - Absorption of new technical and organizational solutions - Low cost of activity - Entrepreneurship and creativity in the scope of looking for new solutions, new ideas and new areas of activity - Adaptive easiness in scope of adaptation to the new place, time and stores- functioning in all branches of the economy. In Poland they constitute over 99% of all registered business entities. They create around 50% of gross domestic product (GDP ) constituting the position of over 67% of the population. The essential criteria classifying enterprises as belonging in the small, medium and large category are the number of people employed and annual average turnover or a balance sum expressed in euro.

Table 3. Enterprises according to the number of employees Specification

2006 (for

2007 (for

First half-year 2008

Dynamics of

31.12.2006)

31.12.2007)

(for 30.06.2008)

change (2006 = 100)

Micro-enterprise

3 455 565

3 502 303

3 531 531

102,19

Small enterprise

147 393

150 128

152 039

103,15

28 406

28 462

28 665

100,91

4 675

4 715

4 704

100,62

3 636 039

3 685 608

3 716 939

102,22

Medium enterprise Large enterprise Total

Source: own study on the base: Zmiany strukturalne grup podmiotów gospodarki narodowej w 2007 r., GUS, Warszawa 2008, s. 34, Zmiany strukturalne grup podmiotów gospodarki narodowej w I półroczu 2008, GUS, Warszawa 2008: 28.

Chart 1. The structure of enterprises (%) according to size in Poland (2008

5

0,77 4,09

0,12

95,01

micro

small

medium

large

Source: own study The group of enterprises analysed is significant in respect of flexible response to apparent demand, as well as the important element of new job creation. It is assumed that SMEs constitute a stabiliser of the economy, eliminating the threats connected with the periodic slowing down of development. Thanks to their elasticity they influence the development and level of innovation, thus they effectively compete on the market. In Poland the dominating domain of activity of small-sized enterprises are the wholesale and retail trade, small services and the service of other business entities, the service of fixed property, construction, transport, the stock economy and other services, council, social and individual activity. They concentrate their activity mainly in the vicinity of big cities or large clusters of enterprises with which they co-operate and which guarantee them the sale market and access to the qualified workforce.

This phenomenon is connected above all with a simple organizational structure. It enables fast and efficient decision-taking, which is often based on the intuition and experience of the owner. There is a short method of information flow, speed in taking decisions and a precisely regulated responsibility. These businesses are able to respond dynamically and efficiently to the threats and opportunities created by surroundings and consequently to fulfill any suddenly appearing demand. They have a high ability to change the profile of their production and to introduce new goods into the production programmes. However, it should be emphasized that independently of the state in which they function, they share a number of universal problems weakening their activity, hence also the chance of their development and survival (Lauder, Boocock & Presley, 1994; Poutziouris, Binks & Bruce 1999; Pehrsson, 2008). Typical problems, which that kind of enterprise faces concern a lack of managerial competence,

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undercapitalization, disadvantages in the scale of activity but also failure to keep up with the development of the market and to implement modern technological solutions (Pechlaner et al., 2004). The problems and conditions enabling the implementation of innovative solutions are also the essential problem of SMEs in Poland. This barrier is connected mainly with the high cost of elaboration and implementation of modern ideas. This costs often exceeds the abilities of one company, especially micro-enterprises employing nine workers, which constitute 95% of all companies in Poland, according to the statistical investigations of GUS. It is also underlined that implementation of innovations, especially technical and technological ones, is subject to high risk, limiting the influences of the usage of solutions resulting from research.

It should be also be underlined that in spite of the great significance for every economy, the essential influence on the GDP and the creation of new jobs, these enterprises in Poland do not have the right tender strength, which would protect them against aggressive action of both business and institutional entities. They have to adapt to these conditions, which are dictated by an often aggressive environment that limits and curbs their development. This contributes to passive functioning, expressed among others in a low co-operative tendency (Nowak, 2009).

Small-sized enterprises concentrate mainly on the realization of short-term aims. This does not result from their action strategy but from many barriers, which limit and curb the possibilities of their development (Lange, Ottens & Taylor, 2000). Small-sized enterprises, especially micro-enterprises, deplete their short-term reserves of competitiveness, which can lead to loss of competitive position in a period of trade cycle weakness. The consequence of this situation may be bankruptcy. It is indicated that basic barriers can take on the character of: - economical crash barriers, which manifest themselves mainly in exaggerated fiscalism and insufficient own capital; in consequence they contribute to low credit credibility and consequent inability to raise external capital. - Educational barriers, which manifest themselves in imperfection in education, especially in the field of marketing, finances and management - Legal barriers, which are connected with complicated and unstable legal regulations. - Barriers of management, which are connected to the expectations of entrepreneurs to obtain the sales market of the country. 7

- Social barriers connected with the negative image of the entrepreneur, who is often treated as dishonest and incompetent.

4. Barriers in the micro and small-sized enterprise development

In the light of empirical examinations, on the basis of questionnaire surveys run in 2007 and 2008 in a group of 133 entities assigned to the category of small and micro-sized enterprises, attempts were made to analyse the barriers to SME development. According to the employment criterion in the research probe, 29 micro-enterprises employing up to nine workers and 104 small-sized enterprises employing up to 49 workers were identified. However, it should be emphasised that the results obtained from the limited research probe do not constitute a base for generalization, though, they constitute some illustration of the deliberations presented as well as problems in the development of SMEs.

The basic activity domain included production (including semi-finished products, elements and parts), production services (including assembly, the processing of raw materials and conservation services), other services (including marketing, financial, legal and computer services, transport services and construction services) and the wholesale and retail trade. Table 4 presents the particular data concerning the employment structure and activity domains.

Table 4. The activity domains of the probe Domain of activity Production Production service Other services Transport Construction service Trade Total:

Micro-enterprises Number % of readings 3 10,4 9 31,1 6 20,7 2 6,8 5 17,2 4 29

13,8 100

Small-sized enterprises Number % of readings 11 10,6 24 23,1 28 26,9 14 13,5 12 11,5 15 104

14,4 100

Source: own study During the research an attempt was made to identify the basic development barriers that fundamentally influence the competitive position of the entities examined and in a real way influence the improvement in their competitive position. According to the respondents high taxes, problems with payments, inelastic labour legislation and troublesome administrative procedures are the main barriers to development. The condition of the entities examined is

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also made unstable by growing problems in accessing credit and dishonest clients who do not settle outstanding obligations.

Table 5. Barriers to the SME development in the assessment of respondents Barriers to SME development in the assessment of respondents 1 Factor Micro-sized enterprises Small-sized enterprises Readings in % Readings in % Lack of transparency, explicitness of indirect taxes 24 82,75 86 82,7 and income tax from the business activity (VAT) Legal-administrative limitation 23 79,3 78 75,0 Other than payroll costs of work 21 72,4 92 88,5 Difficulties in obtaining access to bank loans 20 68,9 84 80,8 Inflexible labour legislation 20 68,9 81 77,9 Inability to recover debts 16 55,2 75 72,1 Competition from the underground economy 12 41,3 79 76,0 Lack of proper infrastructure 11 37,9 43 41,3 Lack of qualified workers 11 37,9 84 80,8 Low demand on market 10 34,5 55 52,9 Inflation 9 31,0 42 40,4 Outdated technologies and equipment 9 31,0 39 37,5 Unfair competition 8 27,6 24 23,1 1 Enterprise could indicate more than one barrier

Source: own study Gaps concerning the transparency and clarity of taxes, which include value-added tax (VAT), excise tax and income tax on the business activity (i.e. corporate income tax (CIT), personal income tax (PIT)), are fundamental barriers in the development of small-sized enterprises. According to respondents, lack of transparency and clarity in the tax law influences the increase in business risk as well as creating costs that burden the enterprise and influence its financial result, thus lowering its competitive position. It is postulated to legislate a uniform tax law, especially with reference to VAT. Unfortunately, in connection with the drastic budget situation of the state, the government considers raising some taxes, including VAT. The amount of income tax is also a serious problem for a large group of enterprises. At the moment, a 19% rate is in force in Poland, which is much higher than in other countries of the region. For example, in Lithuania, Latvia, the Czech Republic and Bulgaria a 15% rate is effective, in Hungary it is 16% and in Slovakia a 19% rate is valid. The demand of smallsized enterprises for a reduction in the tax rate is also justified by the small capital of these entities. This situation, in addition, curbs their investment possibilities and directly influences their competitiveness.

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Chart 2. Factors and their influence on company development

24.1

unfair competition

18.5

7.2

50.2 0.8

outdated technologies and equipment

36.1

15.9

47.2 4.2

36.7

inflation

16.3

42.8 1.5

38.3

low demand on market

40.1

20.1 1.6

a lack of qualified workers

48.9

43

6.5 1.2

a lack of proper infrastructure

40.6

22.1

36.1 1.8

competition from the underground economy

68.4

22.6

7.2 0

unrecoverable-ness of debts

68.4

24.6

7 0.3

inflexible labour legislation

75.9

19

4.8 2.3

dificulties in the access to bank loans

78.2

13.3

6.2 1.9

other than payroll costs of work

84.9

10.2

3.1

2.1 legal-administrative limitation

75.9

16.6

5.4 1.6

82.7

taxes barriers

0 difficulty

20

40

lack of influence

12.1

60 facilitation

80

3.6

100

120

lack of answer

Source: own study For over 88% of the small-sized enterprises and 72% of micro-enterprises, other than payroll costs of work are the essential problem. PAt presents these costs amount to about 170% of the net salary of a worker. These costs limit the competitiveness of SMEs and above all they influence their tendency to employ recruits. In the period of dramatically rising unemployment occurring in September2009, 10.9% of potential workers, which means over 1

10

million people, were unemployed. A decrease in the cost of work would significantly reduce unemployment. According to the respondents a decrease in other than payroll costs would contribute to the creation of new jobs, both through an increase in employment and the liquidation, to a considerable degree, of the underground economy.

The functioning of the underground economy, estimated at 19 to 25%, is another barrier effectively limiting the competitiveness of small and micro-sized enterprises. The underground economy is connected with suppressing part of enterprise profits from the tax office and employing people without reporting this to the relevant offices. It is assessed that even up to the 30% of the unemployed may obtain incomes from the underground economy. Their situation is not comfortable, as the employers do not pay the fees for health, pension and social insurance. In the opinion of respondents most people work illegally in the construction and transport sectors. These businesses conceal up to 40% of their profits. For the enterprises functioning in accordance with the law, the functioning of the underground economy lowers their competitiveness owing to the costs they have to pay, which significantly exceed the costs incurred by dishonest entities. In addition the organisations of the underground economy effectively fight for contracts, competing mainly through price. The functioning of the underground economy is mainly connected with the exaggerated settlement of regulations, their ambiguity and the exaggerated fiscalism of the state. Inelastic labour legislation is also an essential barrier to the development of small-sized and micro-enterprises. In spite of repeated amendments of the employment code, the managers of 69% of micro-enterprises and 79% of small-sized enterprises think that it still does not meet the demands of modern economies. These entities build their competitive position on the base of quality and specialization, but above all the ability to accommodate themselves to the requirements of individual customers. The realization of such a strategy compels the building up of workers' teams of a different kind on the basis of elastic forms of employment. However, Polish law is unable to apply elastic forms of employment. It results in a decrease in competitiveness and lack of possibilities to adapt to the quickly changing environment. Another consequence connected with inelastic labour legislation is lack of qualified personnel. In spite of extensive unemployment, many entrepreneurs still seek qualified workers. It is connected with the structural incongruity of education for the requirements of the market economy. In Poland education is still based on too wide school programmes instead of educating for concrete professions. Polish graduates have huge knowledge of different areas but they are unable to use it in concrete employment situations. This problem 11

is increased by the emigration of the best educated workers to different states of the EU in which they can receive a much higher salary for the same work and avoid early retirement. For around 76% of the examined probe, troublesome and expensive administrative procedures of different kinds also influence their competitiveness. These result from improper laws, poor interpretation of the law and lack of qualifications among a considerable percentage of office workers. Different interpretation of the same regulations, by different tax offices located in different towns, is a typical example. In addition, the decrease in competitiveness is affected by lengthy procedures conducted by by government offices, such as frequently overlapping inspections of all sorts of organs entitled to control, as well as the requirement for enterprises to prepare numerous documents and to store them for a period of several dozen years (e.g. necessity of storage, for a period of 50 years in paper format, of documents on which the calculation of pensions is based). According to the respondents a need to track and analyse the changing regulations which determine the principles of enterprise functioning, as well as the cost of the time lost in satisfying the official formalities, are the essential problems connected with administrative barriers. Another barrier worth mentioning is escalation of payment blocks, which bring small-sized and micro-enterprises to the brink of bankruptcy. Dominating entities, usually with considerable tender power, dictate the conditions for co-operation but they rarely fulfill the established principles.

CONCLUSIONS

The results of questionnaire surveys, carried out in a group of small-sized and microenterprises, show that the elements they have no influence on, have the most significant effect on a decrease in their competitiveness. However, they notice positive aspects, such as access to new financing sources like bank loans and subsidies from the EU or the National Disabled Persons Rehabilitation Fund. Moreover, many entrepreneurs have also recruited new competent workers, expanded the qualifications of employed personnel, developed sales markets, attracted new customers and kept the continuity of orders. REFERENCES

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